An Ultimate Guide to Cost-Based Pricing 2025

Guest post

Your pricing model can be instrumental to your business profitability, growth, and success. But amid the various strategies out there, cost-based pricing remains the most popular in business across all industries. Why? This pricing method is quite simple and easy to apply or implement!

The rule of thumb is simple: You calculate the costs and add a markup, and you’ve got the right price for your product. However, there’s more to this than meets the eye.

Don’t worry – This page is your e-commerce and retail pricing guide. Learn more about cost-based pricing, its types, and key differences from other pricing structures. Weigh its potential benefits and drawbacks and apply the steps for implementing your strategy this year.

Let’s dive right in – read on!

What Is Cost-based Pricing?

Cost-based pricing is precisely what it sounds like – setting prices for products or services based on the overall expense incurred in the whole production process. However, it often comes with a markup by a certain percentage as a way to gain profits from selling. In simple words, you get the total cost and add an extra amount for the set price.

But what expenses are usually calculated in cost-based pricing? Below are direct and indirect costs often involved in the calculation of prices:

Direct costs – costs directly tied to the production of goods or services, such as the following:

• Raw material supplies 
• Labour workforce salaries
• Manufacturing overhead
• Production equipment and tool costs

Indirect costs – expenses not directly linked to the production process but vital for business operations like those as follows:

• Administrative expenses 
• Marketing and sales costs 
• Facility expenditures
• Taxes and insurance 

A pricing strategy is a structured system that companies or organisations use to establish specific prices for particular products and/or services. Cost-based pricing is one of the most common pricing strategies used by businesses of all sizes across different industries. However, it’s best for the manufacturing and service-based industries as well as government projects and business-to-business (B2B) models.

Find out the different types of cost-based pricing below.

Types of cost-based pricing

Cost-based pricing comes with various strategies. The most common types are cost-plus and break-even pricing. The prices for both types depend on the costs; however, they slightly vary in terms of the markup. How are they actually different? Take note of the following:

• Cost-plus pricing involves calculating the total cost of producing a product and adding a fixed percentage as profit. This markup ensures the business earns a return on each unit sold. This method is quite simple and easy to apply best for industries like manufacturing, contracting, and retail.

• Formula: Selling Price = Total Cost + Markup
• Example: If a product costs $50 to make and the company applies a 30% markup, the final price would be $65. 

• Break-even pricing sets the product price at a level where the business covers all its costs but earns no profit, at least initially. The goal is to just ‘break even’ as the name would suggest. It’s ideal for gaining market entry or attracting price-sensitive customers. This strategy is often used in financial forecasting and pricing analysis to evaluate viability before adding profit margins.

• Formula: Price = Fixed Costs + Variable Costs / Number of Units
• Example: If fixed costs are $10,000, variable costs per unit are $20, and the goal is to sell 500 units, the break-even price would be $40 per unit.

Let’s look at how cost-based pricing compares to other pricing methods below.

Key differences with other pricing strategies

Businesses use a variety of pricing strategies. Each method is best tailored to their specific industry, goals, and market dynamics. Here’s the catch: The right pricing approach can significantly impact your profitability and competitiveness. What pricing strategy applies to your business?

PricewaterhouseCoopers (PwC) crunches the numbers: Nearly 60% of companies still rely on simple pricing models like cost-based and competitive pricing, proving their widespread appeal. Another strategy to consider is value-based pricing, also notable in today’s business landscape.

To further understand how cost-based pricing works, let’s compare it with the other two methods:

• Cost-based pricing: As explained, the method is simple – Calculate all production costs and add a markup to set the selling price. It’s straightforward, reliable, and effective since it ensures all your expenses get covered. But it doesn’t always reflect market demand or what customers are willing to pay.

• Value-based pricing: This method flips the script – it sets prices based on how much customers believe your product is worth, hence the name ‘value.’ It’s ideal for standout offers like white-label support or premium services where customer perceptions drive pricing power. 

• Competitive pricing: Here, the focus is on your rivals – You look at what others charge and set your prices accordingly. Think of saturated markets like ERP software for the metal industry, where you base your costs on the standard market pricing amidst your competitors. 

Discover and weigh the pros and cons of cost-based pricing below.

The Pros and Cons of Cost-based Pricing

As mentioned, cost-based pricing is one of the most widely used strategies in business – for good reason. It’s quite simple to implement while offering sure-fire transparency. More importantly, it helps minimize your financial risk by ensuring all your costs get covered.

But as with any strategy, cost-based pricing isn’t a one-size-fits-all solution. Depending on your industry, business model, target market, and sales goals, this method can also have potential pitfalls. You don’t want to commit these mistakes at all!

Take a glimpse of its key benefits and potential drawbacks for informed pricing decisions.

Potential advantages

• Simple and transparent pricing strategy: It’s easy to use and explain – you simply add a markup to your costs, and voila, you’re done!

• Data-driven pricing decisions: You’re basing prices on real numbers, not guesswork or gut feeling.

• Guaranteed cost coverage: It helps ensure you’re not selling at a loss since all costs are factored in.

• Applicable pricing for new products: It’s best for setting starting prices when you don’t have much sales data yet.

• Informed financial investments: The cost breakdown helps you understand returns and plan more brilliant business moves.

Possible disadvantages

• Misalignment risk with market pricing: Your price might end up too high or too low compared to what’s happening in the market.

• Lacking incentives for cost reduction: If profit is always added on top of costs, there’s less push to cut expenses.

• Possible vulnerability to unexpected costs: Sudden cost increases can throw off your pricing and hurt your bottom line.

• Disregard for customer value perception: It doesn’t consider what your product is actually worth to your customers.

• Uncompetitive pricing in dynamic markets: In fast-moving industries, it can make you less agile and out of sync with competitors.

Learn how to set up your cost-based pricing strategy in the next section.

How To Implement a Cost-based Pricing Strategy

Now that you know what cost-based pricing is all about, it’s time to put it into action. The steps are straightforward; However, they call for solid planning and attention to detail.

So, let’s get right to it – here’s how to implement your cost-based pricing strategy step by step.

1. Research on the standard market pricing 

The initial step is to perform due diligence to unravel the market pricing in your area and niche. Using reliable tools, you can conduct price monitoring for your products/services or similar ones. Of course, consider key factors, such as your geographical location, market demand, and consumer behavior. This will give you at least an idea of the range of prices!

Adam Young, CEO and Founder at Event Tickets Center, recommends conducting market research and pricing analysis. Their ticketing centre has to undergo these crucial steps before establishing prices to avoid overpricing or underpricing.

Young says, “Before setting any price, you’ve got to know where you stand in the market. A little upfront research can save you from pricing too high or too low. It’s really about finding that sweet spot customers are willing to pay.”

He relates this to implementing cost-based pricing. “Even with cost-based pricing, market research still matters. Knowing what others charge helps you set a markup that keeps you competitive, not just profitable.”

2. List and calculate all your expenditures

The next step is to list all the expenses involved in the production of your goods or services. Then, sort all your units and their corresponding expenditures for a comprehensive cost analysis. You can harness the power of automation – leverage pricing intelligence software not only to record but also to calculate your expenses.

Nicolas Breedlove, CEO at PlaygroundEquipment.com, suggests an accurate, thorough, and complete expense listing and cost analysis. He believes that these steps are key to a successful cost-based pricing. “That is, if you want not just to break even but earn more profits.”

Breedlove explains, “With cost-based pricing, you can’t afford to guess your numbers. A full breakdown of every expense – no matter how small – helps ensure your pricing actually covers costs and brings in profit.”

3. Set your initial pricing for products in place

Now, you’ve reached the most critical step – pricing your products or services. After your market research and cost analysis, you can set the initial price for items or units. You can employ cost-plus for your regular products/services or the break-even pricing for newly launched offerings. Then, you can experiment with prices later on as a way to boost your sales. 

Learn from John Grant, founder and CEO at Premier Bidets, who has his fair share of experience utilizing cost-based pricing for a wide range of bidet products. 

Grant shares, “Sure, we come up with the prices of our bidet products after getting the total production costs and adding a little markup for profits. However, we must regularly perform market research and cost analysis as product expenses constantly rise and change. At times, we end up using the break-even pricing to retain loyal customers.”

4. Monitor and update your prices when necessary

The final step is to track and adjust your prices – consider our repricing guide. Why? The production costs and market demands are ever-changing, so you should align both to avoid underpricing or overpricing. Fret not, as you can leverage pricing optimization software since its global market demand could expand at a 16.16% compound annual growth rate (CAGR).

Take it from Holly Finnefrock, Founder and CEO at Everblue Pond. In particular with their pricing structure for pond-related products, their company relies heavily on cost-based pricing. “But since the expenses go up and down, we must monitor our prices and adjust them when necessary.

Finnefrock gives a concrete example, “With cost-based pricing, we can’t just set it and forget it. Costs shift all the time—materials, labor, shipping—so we keep a close eye and tweak our prices as needed to stay profitable and fair. For instance, when the price of pond liner materials spiked last year, we had to adjust our pricing to avoid eating into our margins.”

Final Words

Cost-based pricing remains popular and effective in business across different industries. It’s simple and transparent with data-driven decisions and ensured cost coverage. However, it might be misaligned with the market prices, susceptible to unforeseen costs, and subject to a lack of value and competition. So, before taking the plunge, weigh its pros and cons!

Once you’re decided, follow the crucial steps above to implement your cost-based pricing structure. Study the market and analyse your expenditures to set your initial prices. However, monitor your performance in the long run and update your pricing as needed. With all these key tips and steps, you’ll maximise your ROI for business profitability and growth!

Looking to optimize your pricing strategy this year? Dealavo offers robust price monitoring tools for e-commerce businesses. Sign up today to request a demo!